A recent survey finds only 31 percent of companies report success
in sustaining a positive impact for at least five years, but companies can use
variable-pay programs to help sustain new business imperatives.

By Peter Gundy and Tim W. Weiler

Tuesday, November 26, 2013

When was the last time you bought a typewriter or an adding
machine or printed encyclopedia? What happened to the companies that
manufactured those products? You may be surprised to learn that some of
them are still thriving today, including notable companies like IBM and ones
that have reinvented themselves like Smith Corona. Much of our day-to-day
experience has been transformed by disruptive technologies, industry
consolidations, changing consumer preferences and buying behaviors, and these
are major drivers of massive shifts in industries such as high technology,
publishing, telecom, and consumer products.

What separates Apple from Wang or Shutterfly from
Fotomat? How does a company transform itself successfully? To be
sure, real success is derived from a significant change management effort that
only a few companies can pull off and -- importantly -- sustain over time. Our
recent survey of companies that have undergone significant change initiatives
shows that only 31 percent report success in sustaining a positive impact for
at least five years.

In the wake of an industry transformation, human resource
managers and business leaders are faced with the challenge of moving their
organization from an "old world" to a "new world". This
article focuses on the companies that succeeded in transforming themselves and
how they used variable pay programs to expedite the process.

Why Industries Change

There are many forces that trigger shifts to an industry and
force companies to reinvent themselves. Among these forces are three
significant ones:

Media Convergence

Regulation/De-regulation

Commoditization

Media Convergence

This term refers to the tendency of different technologies
to evolve toward performing the same task. The digital revolution has created
so many new avenues for companies to reach their customers and to tap new
demographics. For example, broadcasting and entertainment have been affected
dramatically by this wave, with content being made available on TV, online, and
handheld devices. Convergence has also threatened the revenue model in
industries like broadcasting that have relied heavily on advertising revenues
through the traditional print media and on selling printed copies as a way to
protect intellectual property.

Regulation/De-regulation

There are numerous examples of regulatory intervention (or
deregulation) that have changed the landscape in many industries. A notable
example is The Fair and Accurate Credit Transaction Act that became law in
December of 2003, which provided that consumers have a legal right to a free
credit report. While some credit score providers were already providing credit
scores, this legislation cemented a permanent change for the industry. Credit
reporting and credit-card companies everywhere in the U.S. began to diversify
into personalized financial services (e.g., identity theft protection) and data
mining services (e.g., predictive modeling to inform consumer marketing
decisions).

Commoditization

Commoditization occurs when the market becomes saturated
with competitive substitutes and with disintermediation. For example, office
suppliers, distributors, and technology companies have adapted their business
models dramatically over the years. These companies have differentiated
themselves by providing value-added services on top of price-competitive
products. Office supply superstores, for example, now compete in two additional
categories: computer hardware and document services.

Why Variable Pay Matters

Many things have to go right for a company to be successful
in adapting to change. A new strategy needs to be developed, the business model
may need to change, and new types of skills and capabilities are often
required. In nearly all cases, organizations will also use incentive
compensation to support the change initiative.

The debate about whether or not variable pay truly drives
behavior continues today. We don’t, in this article, seek to resolve this
debate. In our experience, however, incentive compensation is one of the most
effective tools a company has to achieve four basic objectives:

Convey to existing employees "the new path to
success" -- what the company now values, what new behaviors are
desired, what new results need to be achieved, and how these new results will
be measured

Align and vary compensation costs with performance so that
the company can modulate its investment in new markets

Attract employees with new skills or risk tolerances to help
propel the company into new markets or geographies

Signal to low-performing employees or those unwilling to
change behavior that it may be time to select out.

These four objectives are critical to a successful business
transformation.

Seven Lessons from the Front Line

So what have companies that have successfully navigated from
the "old world" to the "new world" done to motivate new
business imperatives with their variable compensation programs? In our
experience, these leaders apply seven basic principles:

1. Create a clear understanding of the
imperative for change

The business case for change must be well understood to
ensure employees understand the context for changes in compensation and other
programs. The core purpose for such change should be reinforced in all
incentive pay, performance management, and measurement communications. Consider
the case of a technology company that was combatting the commoditization of its
hardware by reinforcing the importance of a cross-selling and solutions
orientation. Their objective was to reinforce with customers that they were not
just buying products but rather a unique bundle of products and services that
would solve their business problem (which could be priced based on value and
drive stronger profitability). As part of their incentive communications, this
company outlined examples of how single product/service customers had eroded
its profits margins over time as compared to multi-product/service customers. 2. Use performance measures to communicate both desired results and
behaviors

The adage of "what gets measured gets managed and what
gets managed gets done" is often used cynically to describe archaic
management practices. Yet compensation professionals understand that there is
an art to using performance metrics effectively. When line-of-sight measures
are used in incentive plans and there is confidence in the goals and the
underlying performance data, employee engagement and buy-in goes up. A national
equipment rental company (an industry that has faced its own
"convergence" of commercial and retail providers) was facing
increased price competition from local "mom and pop" operators so it
was imperative to meet minimum pricing standards to protect profitability.
Incentive measures were added to both the sales and operations pay plans to
reward those who protected and exceeded price expectations -- which pushed
sellers to focus on the value proposition of renting from a full-service
provider (faster delivery, and fewer costly delays due to breakdowns).

3. Set pay mix to promote the appetite for risk

A vital part of reinventing a business is innovation and
risk-taking. In nearly all cases cited in this article, the companies increased
the percentage of total compensation derived from incentive compensation.
Successful companies have used pay mix as a way of signaling a new posture
toward risk. One publishing company that was responding to the convergence
described earlier was looking to change its pay practice to promote risk-taking
and innovation and to reflect the practices of the smaller, start-up digital
companies it was acquiring. Variable pay was increased over three years with a
combination of reduced merit budgets and increased incentive targets. Selected
leaders of the organization were also given the opportunity to forgo portions
of their salary in exchange for a disproportionate increase in target incentive
pay.

4. Balance risk-taking with risk management

Consider the impact recent regulation on the treatment of
incentive pay in financial services brought on by the Dodd-Frank Act. The
risks and consequences of a financial transaction can span many years after
incentives are paid to those who involved in the deal (e.g., most mortgages
span 15 to 30 years, which is a long time, but they can be as long as 100 years
in countries like Japan). In addition to reorganizing their business model to
address new capital requirements and other regulatory requirements, many banks
now defer payment of a portion of the cash bonus over three- to four-year
periods respond to risk-balancing concerns. Pharmaceutical organizations, faced
with lawsuits alleging off-label sales / promotion practices have shifted to
less pay at risk and balanced incentive plan production measures with physician
satisfaction and key objectives tied to demonstrating skills.

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Don’t underestimate the need for competency development
and personalized touch to reinforce the new deal

Compensation is the most sensitive nerve in the body and any
changes are bound to create organizational and personal anxiety. The U.S. Do
Not Call Act of 2003 prohibits open telemarketing to the general public but
does all allow companies to solicit existing customers.

Shortly after its enactment, many companies (e.g., insurers,
credit card companies) revamped their incentive plans for customer service
representatives -- to include not just efficiency metrics, but sales metrics as
well. In this example, regulation fundamentally changed the role of the service
rep, necessitating sales competency development, training, communication, and
even one-on-one discussions about the new incentive program and ways to
maximize personal earnings.

6. Use goal-setting and incentive leverage to address
urgency and degree of influence

The goal-setting process can be used to lend credibility to
the change effort. Leading companies set realistic goals, particularly in the
early years of the change effort, because they know that success itself can be
a powerful motivator. The use of performance thresholds in incentive plans
convey the floor for results for the plan, but also establish the tolerance of
downside performance. Conversely, the upside leverage communicates the payoff
for taking risks. The interplay of thresholds and upsides can send a powerful
message to employees about how an organization is willing to back employees who
take appropriate risks and how it can shield others who have less influence on
the overall results.

7. Avoid complex program changes; keep the messages
simple

Avoid introducing too many new performance measures and
overloading existing plans with more components. Introduce new plans that are
clear, easy to understand, and reinforce the 3 or 4 main themes/business
objectives of the change effort -- ensuring the incentive programs are easy to
figure out. One organization undergoing a business transformation attempted to
roll out a plan with seventeen different performance measures, which is what
encompassed (or so they thought) exactly all of the things they wanted
employees to focus on. The plan was scrapped after one year.

Incentive Pay Is Not the Whole Solution, but it is a
Key Driver of Change

When companies take on strategic change based on forces
affecting an entire industry, "turning the ship" can lead to market
leadership or the organization can go the way of the Titanic. A broader view of
the business strategy is required, one that translates into specific
organizational, human capital, and financial imperatives that are actionable.
Equally important are the financial incentives that help focus attention and
speed change.

A new incentive plan needs to have the "chops" to
deliver on management’s objectives. In other words, the downside and upside of
incentive programs and degree of differentiation should be significant enough
to instill the appropriate level of "fear of consequence and promise of
rewards" among employees. New incentive plans that deliver on this promise
avoid the "this too shall pass" attitude that can dampen a change
effort and potentially condemn a company to obsolescence.

While not a "silver bullet", incentive plans that
are properly designed and communicated can improve the odds that a firm ends up
in the 31 percent of companies cited earlier that sustain the benefits of its
transformation for at least five years. And maybe longer.